The banking industry's biggest problem isn't bonuses or market share

The only way to make the sector pursue long-term viability instead of short-term greed is to change the rules of the game

• 
• • Ha-Joon Chang
  • The Guardian, Wednesday 22 January 2014

‘The fact that the political class, including Miliband himself, cannot even imagine state-owned banks ditching the business model that caused this crisis is a testimony to the power of the financial industry lobby.’ Photograph: Stefan Rousseau/PA

Last Friday, in another of those agenda-setting speeches for which he has rightly become famous, Ed Miliband took on the biggest of what he describes as "the broken markets" in the UK economy – the financial market.

Taking his "cost of living crisis" theme to another level, the Labour leader emphasised that the issue is not just about oligopolistic firms fleecing their customers; it is also about the lack of jobs with decent wages that can support decent standards of living. The problem with the British banking industry, Miliband pointed out, is not just about the concentration of financial power in the personal account market, but also in the business loan market.

According to Miliband's analysis, the dominant banks are not lending enough to small and medium-sized enterprises because they form a cosy oligopoly (controlling 85% of small business lending) that does not want to take any risk; enterprise loans are inherently riskier than mortgage and personal loans. Given that small businesses create most jobs in the UK (as they do in all countries), lack of finance for them is limiting the creation of decent jobs. The solution, he argued, is to introduce more competition into the small business lending market by capping the share of individual banks.

This proposal has caused much controversy. However, one thing is certain: it is going to be slow-acting. It may be years before proper "challenger" banks emerge, given the time necessary for the review by the Competition and Markets Authority – which takes over the roles of the Competition Commission and Office of Fair Trading from April – and for the process of selling branches.

But there is a quicker and simpler solution to this problem. It is for the government to use its ownership of two of the big four banks, RBS and Lloyds, to direct more lending to small businesses. Thanks to the bailout following the 2008 financial crisis, RBS is 81% owned by the government. This means it can tell RBS what to do. It also owns 33% of Lloyds, and while this does not give it a total control over the bank, it is well above what is normally considered a "controlling stake" in an enterprise.

Now, if you can basically tell two of the four largest banks what to do – say, to increase lending to small businesses – why go through the rigmarole of calculating their market shares and forcing them (and the other two) to sell off some of their branches?

The usual refrain is that Westminster cannot make RBS and Lloyds do things differently because, in order to survive, these banks need to behave like other competitors: generating as much profit and paying their staff as much.

This argument may be right if the existing business model of British banks and other financial companies is fine. But it is not. It is a business model that has caused the biggest financial crisis in 70 years and created imbalances and inequalities that threaten the future viability of the British economy. The fact that the political class, including Miliband himself, cannot even imagine state-owned banks ditching such a model is a testimony to the power of the financial industry lobby.

From the day when RBS and Lloyds were bailed out, the Labour government was at pains to emphasise it would run them along the same lines as before nationalisation. The only thing for which Labour and, subsequently, the coalition government have used the government's dominant shareholding position has been to restrain bonuses. But this is really missing the point.

The problem with bonuses in the financial industry is not about their levels – if someone makes a huge contribution to the economy, he or she should be richly rewarded. The main problem is that these bonuses are given to people for doing the wrong things well – things that harm the economy in order to enrich the shareholders, the top managers of banks and other financial firms.

So the real question is how we make banks and other financial firms pursue the right goals, rather than how much people should be paid, whether in bonuses or salaries. And the only way to make them pursue different goals from those they pursue now is to change the rules of the game.

Unfortunately, few regulations have been introduced since the crisis that have materially changed the goals of financial companies. The result has been "business as usual".

All those complex and risky financial products that were at the centre of the 2008 financial crisis – such as mortgage-backed securities, collateralised debt obligations, credit default swaps and other financial derivatives – are back in vogue again.

The credit rating agencies, whose incompetence and cynicism in rating those financial products has become legendary after the crisis, are still operating in the same way.

Thanks to Help to Buy, the mortgage-lending market is nearly back to its old self. Now you can get loans that are 95% equal to the value of the house – not quite the 125% you could get before the crisis, but nearly there.

In the absence of measures to encourage longer-term shareholding – for instance, by granting more votes or tax advantages – short term-oriented shareholders are still reigning supreme, putting pressures on banks to generate short-term profits, whatever the consequences.

The main problem with the British financial industry is not the level of bonus, or even the concentration in the banking sector; it is that the industry is pursuing goals that are detrimental to the long-term economic viability of the country, in the process enriching only a tiny minority and sapping human and financial resources from the rest of the economy.

Unless those goals are changed through better regulation, the industry will remain harmful to the rest of the economy, whatever we do about bonuses and market concentration.

Emerging market rout threatens wider global economy

The $9 trillion (£5.8 trillion) accumulation of foreign bonds by the rising powers of Asia, Latin America and the emerging world risks going into reverse as one country after another is forced to liquidate holdings to shore up its currency, threatening to inflict a credit shock on the global economy.

Fears of Fed tightening have pushed borrowing costs worldwide to levels that could threaten global recovery Photo: AFP

By Ambrose Evans-Pritchard in The Telegraph

8:38PM BST 22 Aug 2013

India’s rupee and Turkey’s lira both crashed to record lows on Thursday following the US Federal Reserve releasing minutes which signalled a wind-down of quantitative easing as soon as next month.

Dilma Rousseff, Brazil’s president, held an emergency meeting on Thursday with her top economic officials to halt the real’s slide after it hit a five-year low against the dollar. The central bank chief, Alexandre Tombini, cancelled his trip to the Fed’s Jackson Hole conclave in order “to monitor market activity” amid reports Brazil is preparing direct intervention to stem capital flight.

The country has so far relied on futures contracts to defend the real – disguising the erosion of Brazil’s $374bn reserves – but this has failed to deter speculators. “They are moving currency intervention off balance sheet, but the net position is deteriorating all the time,” said Danske Bank’s Lars Christensen.

A string of countries have been burning foreign reserves to defend exchange rates, with holdings down 8pc in Ecuador, 6pc in Kazakhstan and Kuwait, and 5.5pc in Indonesia in July alone. Turkey’s reserves have dropped 15pc this year.

“Emerging markets are in the eye of the storm,” said Stephen Jen at SLJ Macro Partners. “Their currencies are in grave danger. These things always overshoot.” 

It was Fed tightening and a rising dollar that set off Latin America’s crisis in the early 1980s and East Asia’s crisis in the mid-1990s. Both episodes were contained, though not easily.

Emerging markets have stronger shock absorbers today and largely borrow in their own currencies, making them less vulnerable to a dollar squeeze. However, they now make up half the world economy and are big enough to set off a crisis in the West.

Fears of Fed tightening have pushed borrowing costs worldwide to levels that could threaten global recovery. Yields on 10-year bonds jumped 47 basis points to 12.29pc in Brazil on Thursday, 33 points to 9.72pc in Turkey, and 12 points to 8.4pc in South Africa.

There had been hopes that the Fed might delay its tapering of bond purchases, chastened by the jump in long-term rates in the US itself. Ten-year US yields – the world’s benchmark price of money – have soared from 1.6pc to 2.9pc since early May.

Hans Redeker from Morgan Stanley said a “negative feedback loop” is taking hold as emerging markets are forced to impose austerity and sell reserves to shore up their currencies, the exact opposite of what happened over the past decade as they built up a vast war chest of US and European bonds.

The effect of the reserve build-up by China and others was to compress global bond yields, leading to property bubbles and equity booms in the West. The reversal of this process could be painful.

“China sold $20bn of US Treasuries in June and others are doing the same thing. We think this is driving up US yields, and German yields are rising even faster,” said Mr Redeker. “This has major implications for the world. The US may be strong to enough to withstand higher rates, but we are not sure about Europe. Our worry is that a sell-off in reserves may push rates to levels that are unjustified for the global economy as a whole, if it has not happened already.”

Sovereign bond strategist Nicolas Spiro said India is “caught between the Scylla of faltering growth and the Charybdis of currency depreciation” as hostile markets start to pick off any country with a large current account deficit. He said India’s central bank is playing with fire by reversing its tightening measures to fend off recession. It has instead set off a full-blown currency crisis that is crippling for companies with dollar debts.

India is not alone. A string of countries across the world are grappling with variants of the same problem, forced to pick their poison.

Church of England wants to 'compete' Wonga out of existence

Archbishop of Canterbury lays down challenge to payday lender after launching new credit union earlier this month

• Press Association
• guardian.co.uk, Thursday 25 July 2013 00.16 BST

The Most Rev Justin Welby, archbishop of Canterbury, says he has had a 'very good conversation' with Wonga's chief executive. Photograph: Dominic Lipinski/PA

The archbishop of Canterbury has told Wonga that the Church of England wants to "compete" it out of existence as part of its plans to expand credit unions as an alternative to payday lenders.

The Most Rev Justin Welby said he had delivered the message to Errol Damelin, chief executive of Wonga, one of Britain's best-known payday lenders, during a "very good conversation".

"I've met the head of Wonga and we had a very good conversation and I said to him quite bluntly 'we're not in the business of trying to legislate you out of existence, we're trying to compete you out of existence'," he told Total Politics magazine.

"He's a businessman, he took that well."

The archbishop's remarks come after he launched a new credit union for clergy and church staff earlier this month at the General Synod in York.

Welby, who has served on the parliamentary Banking Standards Commission, has said he plans to expand the reach of credit unions as part of a long-term campaign to boost competition in the banking sector.

There are also plans to encourage church members with relevant skills to volunteer at credit unions. Small, local lenders could also be invited to use church buildings and other community locations with the help of church members.

The government announced an investment of £38m in credit unions in April to help them offer an alternative option to payday lenders.

The entire pay day lending industry, worth £2bn, was referred last month for a full-blown investigation by the Competition Commission after the trading watchdog uncovered "deep-rooted" problems with the industry.

The Office of Fair Trading said it decided to make the referral because it continues to suspect that features of the market "prevent, restrict or distort competition".

Wonga said in March that it welcomed any attempt to encourage responsible lending and that it has been "instrumental" in helping to raise industry standards.

Damelin, founder of Wonga, said: "The archbishop is clearly an exceptional individual and someone who understands the power of innovation.

"We discussed the future of banking and financial services, as well as our emerging digital society.

"There is mutual respect, some differing opinions and a meeting of minds on many big issues.

"On the competition point, we always welcome fresh approaches that give people a fuller set of alternatives to solve their financial challenges. I'm all for better consumer choice."

Welfare fraud is a drop in the ocean compared to tax avoidance

As Joanne Gibbons' case shows, benefit underpayments save us more than 'cheats' cost us. We need to target the real villains

• 
• • James Ball
  • guardian.co.uk, Sunday 3 February 2013 12.06 GMT

Had Gibbons claimed the benefits to which she was entitled she could have collected double her 'fraudulent' claims. Photograph: Peter Macdiarmid/Getty Images

 

Joanne Gibbons was sentenced to community service for claiming income support while holding down two paid jobs. Through accumulated payments of £66-a-week, the court heard, she collected £3,140 to which she wasn't entitled.

Predictably, the Daily Mail is outraged. But here's the strange twist: had Gibbons claimed the benefits to which she was actually entitled, she could have collected £130 a week through family tax credits and child benefit. In total, Gibbons' fraudulent claims cost the taxpayer around £3,100 less than claiming what she was actually entitled to.

It's the reaction to Gibbons' claims which are particularly noteworthy. Matthew Sinclair, chief executive of the Taxpayers' Alliance – an organisation rarely troubled by wealthy people's tax avoidance – tells the Mail:

"It beggars belief that somebody going to the lengths of making fraudulent claims would have actually received more in benefits had they been honest.

"It just goes to show that the current system is broken and doesn't provide the right incentives for claimants to go back to work."

This quote suggests Sinclair is perhaps even less numerate than the "benefits cheat" he's deriding. Gibbons was entitled to £130 a week in legitimate benefits, while working on two low-income jobs. This total was higher than the £66 a week out-of-work benefit she was improperly claiming (though some of the £130 a week could be claimed in or out of work).

In what sense is a system which tops up low wages a disincentive to work? Sinclair appears lost in lazy rhetoric – an all-too-common failing when it comes to chastising the millions of families, most of whom with at least one adult in work, who rely on the benefit system.

The British public believe benefit fraud is a big problem. A recent poll by the TUC showed people believe 27% of the welfare budget is fraudulently claimed.

The reality is very different. Last year, 0.7% of total benefit expenditure was overpaid due to fraud, according to the DWP's official estimates. This totalled £1.2bn over the year. Nor is fraud getting worse – even against a background of benefit cuts and long-term unemployment fraud made up a smaller share of the welfare bill last year than it did in 2010/11 or 2009/10.

Indeed, welfare fraud is smaller than accidental overpayments due to error, which totalled £2.2bn (£1.4bn of which due to official error). It's also smaller than the amount of money underpaid to those entitled to it: £1.3bn.

In other words, if we wiped out benefit fraud tomorrow – but also eliminated the errors that deprive people of money to which they are entitled – the welfare bill would grow, not shrink.

In the context of the UK's £700bn public spending, and £150bn+ welfare bill (of which pensions and in-work benefits make up the substantial majority), benefit fraud is a relatively small revenue loss. But how does it compare to another textbook villain: tax avoidance?

Put simply, it is comparatively tiny. HMRC consistently estimates the UK's tax gap – the gap between what HMRC thinks it should receive versus what it actually gets – at more than £30bn per year. Others estimate this is far, far higher.

Of this, even conservative estimates suggest around a sixth – £5bn a year – is lost through tax avoidance, tricks to reduce tax bills which fall within the letter (if not spirit) of the law, but often fall outside what's regarded as acceptable by the public. A further sixth, at least, is estimated to be due to wholesale tax evasion: simply illegally not paying the tax that's owed.

These conservative estimates alone outweigh benefit fraud by a factor of eight, but this time not done in tens (or at most hundreds) of pounds per week by people struggling to get by; but rather by people who could afford to pay more, but prefer not to.

Benefit underpayments save us more money than benefit fraud costs us. By the most conservative estimates, tax avoidance and tax evasion outweighs benefit fraud eightfold. But the constant target of argument – "scroungers", "benefit cheats", and more, isn't the well-heeled middle classes who knock a little off their tax return, or the high-rollers with elaborate offshore schemes.

Instead, it's those at the bottom of society – for the government, perhaps, it makes it easier to sell the public swingeing cuts to the safety net that millions of families, both in and out of work, rely on to get by. For the Mail, it's easier to sell papers by buying into the easy preconceptions of their readers than bothering to challenge them.

Unfortunately, all too often, that's a view the Labour party – and others on the left – seem all too happy to go along with. If we must have national villains, surely we can do better than these?

So how long can the US hold the world to ransom with the dollar?

Satyajit Das

On 8 November 2010, the German finance minister Wolfgang Schäuble told the Wall Street Journal: "The USA lived off credit for too long, inflated its financial sector massively and neglected its industrial base."

US gross government debt currently totals around $16trillion (£10trn). The US government holds around 40 per cent of the debt through the Federal Reserve and government funds. Individuals, corporations, banks, insurance companies, pension funds, mutual funds, state or local governments, hold 25 per cent. Foreign investors, China, Japan and "other" (principally oil exporting) nations, Asian central banks or sovereign wealth funds hold the rest.

Historically, America has been able to run large budget and balance of payments deficits because it had no problem finding investors in US Treasury securities. The unquestioned credit quality of the US, the unparalleled size and liquidity of its government bond market, ensured investor support. Given its reserve currency and safe haven status, US dollars and US government bonds were a cornerstone of investment portfolios of foreign lenders.

During this period, emerging countries such as China fuelled American growth, supplying cheap goods and cheap funding – recycling export proceeds into US bonds – to finance the purchase of these goods. It was a mutually convenient addiction .

Asked whether America hanged itself with an Asian rope, a Chinese official told a reporter: "No. It drowned itself in Asian liquidity."

Given the sheer quantum of US debt, foreign investors may become increasingly less willing to finance America. Japanese and European investors, struggling to finance their own government obligations, may simply not have the funds.

Given its magnitude and the lack of political will to deal with the problem of debt and public finances, the US is now deploying its FMDs – "financial extortion", "monetisation" and "devaluation" – to finance its requirements.

In a form of extortion, existing investors like China must continue to purchase US dollars and bonds to avoid a precipitous drop in the value of existing investments.

Debt monetisation – printing money – is another strategy. The US Federal Reserve is already the in-house pawnbroker to the US government, purchasing government bonds in return for supplying reserves to the banking system. Expedient in the short term, monetisation risks setting off inflation. The absence of demand in the economy, industrial over-capacity and the unwillingness of banks to lend have meant successive "quantitative easing" has not resulted in higher inflation to date. But the risks remain.

Monetisation is inexorably linked to devaluation of the US dollar. The zero interest rates policy and debt monetisation is designed to weaken the dollar. As John Connally, the US Treasury Secretary under President Richard Nixon, belligerently observed: "Our dollar, but your problem."

Despite bouts of dollar buying on its safe haven status, the US dollar has significantly weakened over the last two years, losing around 20 per cent against major currencies since 2009. As the dollar weakens US foreign investments and overseas income gain in value. But the major benefit is in relation to debt owned by foreigners. As almost all its government debt is denominated in US dollars, devaluation reduces its value.

This forces existing investors to keep rolling over debt to avoid realising losses. It encourages them to increase investment, to "double down" to lower their average cost of US dollars and debt. It also allows the US to enhance its competitive export position.

Major investors in US government bonds now find themselves in the position John Maynard Keynes identified: "Owe your banker £1,000 and you are at his mercy; owe him £1m and the position is reversed."

Valery Giscard d'Estaing, the French finance minister under Charles de Gaulle, famously used the term "exorbitant privilege" to describe the advantages to America of the dollar's role as a reserve currency and its central role in global trade.

That privilege now is not only "exorbitant" but "extortionate". How long the world will let the US exercise it is uncertain.

Satyajit Das is a former banker and author of "Extreme Money" and "Traders, Guns & Money"

How we fell out of love with Keynes

The same intellectual retreat can be seen all over the western world and it shows that noble intentions and half-decent ideas don't get you very far

• 
• • Aditya Chakrabortty
  • guardian.co.uk, Monday 26 March 2012 20.00 BST

The Greek crisis acted as a parable of what happens when countries borrow too much. Photograph: Anne-Christine Poujoulat/AFP/Getty Images

 

Remember all that talk about never letting a crisis go to waste? All those frontbenchers – from across the political spectrum – who swore that the banking crash would change economic policy for good? Vince Cable and Alistair Darling traded their favourite bits of Keynes and state intervention was firmly back in fashion. Well, you can rip up those fine, fevered promises and stick them in the bin. That at least is the big message out of last week's budget.

Oh, we all know what the papers reported: the granny tax, the kid gloves for the super-rich, and George Osborne's tin ear. But just as notable was what they didn't pick up: any meaningful dispute over the big picture. Labour's two Eds concentrated their attack on the chancellor for the fairness of his individual measures and kept schtum about the overall cuts strategy, of which they are only a small part.

The business lobby applauded the drop in corporation tax and the bungs for Grand Theft Auto and Richard Curtis (or, as they're officially known, relief for the British video games and film industries), but let the coalition off the hook on its promises to rebalance the economy.

How very different from Osborne's previous budgets. Over its first couple of years, Lib Dem wobbles and the European meltdown forced the coalition's austerity programme front and centre in political debate.

As for reform of Britain's listing economy, the strapline for last year's budget was that it would start "the march of the makers". Yet with the euro crisis temporarily on simmer, and the chancellor still clinging to his Plan A, the argument of ideas has gone all-but-silent.

Going by last week's squalls, what has replaced it is a giant scrap about who should lose most: OAPs or the young, the super-rich or welfare claimants.

As the cuts go deeper and further, and living standards remain depressed, this visceral battle of sectional interests will surely only escalate. Meanwhile, the political classes are busy getting back to business as usual. Last week's announcement of infrastructure privatisation suggests the new orthodoxy for Cameron and Osborne: when in doubt, Thatcherise it. As for the banks, where all this began, they are firmly back in charge. You know all about the bonuses, but even more telling is this underreported Treasury announcement from last week: the banks' miserliness with credit has forced Osborne to take £20bn of taxpayers' cash and use it for loans to small businesses. But wait for it: this money – your money – will be given to the same big banks to lend, with the minimum of public oversight. Take it from me: those last two sentences do not improve on rereading.

Blame Tory ideology, if you like, or Labour's failure to offer an alternative, but this is what those fervent avowals from MPs between 2008 and 2010 have given way to. As Old Whiskers might have said: all that is solid melts into hot air.

The same intellectual retreat can be seen throughout the Western world. John Quiggin, author of Zombie Economics, and political scientist Henry Farrell, have just published a fascinating paper charting how governments, central bankers and economists changed in the four years after Lehman's collapse from being "Keynesians in the fox hole" (as one Chicago academic put it) to merchants of austerity.

The tale Farrell and Quiggin tell is a simple, but compelling one. In autumn 2008, the policy-making establishment was in deep panic. The world they had constructed was collapsing around their ears, and ministers and economists had no idea how to respond. Amid this confusion, the long-marginalised followers of Keynes were able to win panicked international support for their economic-stimulus packages and reform of the financial sector. But no sooner had the global economy stabilised than governments and central bankers (led by Jean-Claude Trichet in the eurozone) returned to their old ways. They were urged on by the now-rescued and boisterous finance sector. And of course there was then the Greek crisis, offering a seemingly irresistible parable of what happened to countries that borrowed too much.

Never mind that the Greece story doesn't tell you much about any other country apart from Greece. Never mind that the principal argument of the Keynesians that you don't cut public spending amid a slump is as true now as in 2008. The conclusion one takes away from the past four years is that it wasn't the free-marketeers who were on the wrong side of history – it was all those good-hearted people punching the air and proclaiming the arrival of some progressive moment. The conclusion one takes away from Farrell and Quiggin's paper is that noble intentions and half-decent ideas don't take you very far. You need an adequate political vehicle, which Labour has plainly failed to provide, and some hard-headed analysis too.

Still, there's always the next crisis. And the failure to reform the economy pretty much guarantees that another one will come along.

Putting Growth In Its Place

It has to be but a means to development, not an end in itself

Jean Dreze ,  Amartya Sen

Is India doing marvellously well, or is it failing terribly? Depending on whom you speak to, you could pick up either of those answers with some frequency. One story, very popular among a minority but a large enough group—of Indians who are doing very well (and among the media that cater largely to them)—runs something like this. “After decades of mediocrity and stagnation under ‘Nehruvian socialism’, the Indian economy achieved a spectacular take-off during the last two decades. This take-off, which led to unprecedented improvements in income per head, was driven largely by market initiatives. It involves a significant increase in inequality, but this is a common phenomenon in periods of rapid growth. With enough time, the benefits of fast economic growth will surely reach even the poorest people, and we are firmly on the way to that.” Despite the conceptual confusion involved in bestowing the term ‘socialism’ to a collectivity of grossly statist policies of ‘Licence raj’ and neglect of the state’s responsibilities for school education and healthcare, the story just told has much plausibility, within its confined domain.

But looking at contemporary India from another angle, one could equally tell the following—more critical and more censorious—story: “The progress of living standards for common people, as opposed to a favoured minority, has been dreadfully slow—so slow that India’s social indicators are still abysmal.” For instance, according to World Bank data, only five countries outside Africa (Afghanistan, Bhutan, Pakistan, Papua New Guinea and Yemen) have a lower “youth female literacy rate” than India (World Development Indicators 2011, online). To take some other examples, only four countries (Afghanistan, Cambodia, Haiti, Myanmar and Pakistan) do worse than India in child mortality rate; only three have lower levels of “access to improved sanitation” (Bolivia, Cambodia and Haiti); and none (anywhere—not even in Africa) have a higher proportion of underweight children. Almost any composite index of these and related indicators of health, education and nutrition would place India very close to the bottom in a ranking of all countries outside Africa.

Growth and Development

So which of the two stories—unprecedented success or extraordinary failure—is correct? The answer is both, for they are both valid, and they are entirely compatible with each other. This may initially seem like a bit of a mystery, but that initial thought would only reflect a failure to understand the demands of development that go well beyond economic growth. Indeed, economic growth is not constitutively the same thing as development, in the sense of a general improvement in living standards and enhancement of people’s well-being and freedom. Growth, of course, can be very helpful in achieving development, but this requires active public policies to ensure that the fruits of economic growth are widely shared, and also requires—and this is very important—making good use of the public revenue generated by fast economic growth for social services, especially for public healthcare and public education.

The minority of the better-off forgets that even after 20 years of growth, India’s among the world’s poorest nations.

We referred to this process as “growth-mediated” development in our 1989 book, Hunger and Public Action. This can indeed be an effective route to a very important part of development; but we must be clear about what can be achieved by fast economic growth on its own, and what it cannot do without appropriate social supplementation. Sustainable economic growth can be a huge force not only for raising incomes but also for enhancing people’s living standards and the quality of life, and it can also work very effectively for many other objectives, such as reducing public deficits and the burden of public debt. These growth connections do deserve emphasis, not only in Asia, Africa and Latin America, but also very much in Europe today, where there has been a remarkable lack of understanding of the role of growth in solving problems of debt and deficit. There is a tendency to concentrate only on draconian restrictive policies to cut down public expenditure, no matter how essential and no matter how these policies kill the goose that lays the golden egg of economic growth. There is a neglect of the role of economic growth in economic and financial stability in the European debate, with its focus only on cutting public expenditure to satisfy the market and to obey the orders of credit rating agencies.
Yet it is also important to recognise that the impact of economic growth on living standards is crucially dependent on the nature of the growth process (for instance, its sectoral composition and employment intensity) as well as of the public policies—particularly relating to basic education and healthcare—that are used to enable common people to share in the process of growth. There is also, in India, an urgent need for greater attention to the destructive aspects of growth, including environmental plunder (e.g. through razing of forests, indiscriminate mining, depletion of groundwater, drying of rivers and massacre of fauna) and involuntary displacement of communities—particularly adivasi communities—that have strong roots in a particular ecosystem.

The European debate focuses only on curbing public spend, ignoring the role of economic growth in financial stability.

India’s growth achievements are indeed quite remarkable. According to official data, per capita income has grown at a compound rate of close to five per cent per year in real terms between 1990-91 and 2009-10. The more recent rates of expansion are faster still: according to Planning Commission estimates, the growth rate of GDP was 7.8 per cent in the Tenth Plan period (2002-03 to 2006-07) and is likely to be around 8 per cent in the Eleventh Plan period (2007-08 to 2011-12). The “advance estimate” for 2010-11 is 8.6 per cent. These are, no doubt, exceptional growth rates—the second-highest in the world, next to China. These dazzling figures are, understandably, causing some excitement, and were even described as “magic numbers” by no less than Lord Meghnad Desai, who argued, not without irony, that whatever else happens, “the government can still sit back and say 8.6 per cent”. 

India does need rapid economic growth, if only because average incomes are so low that they cannot sustain anything like reasonable living standards, even with extensive income redistribution. Indeed, even today, after 20 years of rapid growth, India is still one of the poorest countries in the world, something that is often lost sight of, especially by those who enjoy world-class living standards thanks to the inequalities in the income distribution. According to World Development Indicators 2011, only 16 countries outside Africa had a lower “gross national income per capita” than India in 2010: Afghanistan, Bangladesh, Cambodia, Haiti, Iraq, Kyrgyzstan, Lao, Moldova, Nepal, Nicaragua, Pakistan, Papua New Guinea, Tajikistan, Uzbekistan, Vietnam and Yemen. This is not exactly a club of economic superpowers.

Bangladesh and Nepal do not have India’s per capita income but have vastly improved indices.

Having said this, it would be a mistake to “sit back” and rely on economic growth per se to transform the living conditions of the unprivileged. Along with our discussion of “growth-mediated” development, in an earlier book, we also drew attention to the pitfalls of “unaimed opulence”—the indiscriminate pursuit of economic expansion, without paying much attention to how it is shared or how it affects people’s lives. A good example, at that time (in the late 1980s), was Brazil, where rapid growth went hand in hand with the persistence of massive deprivation. Contrasting this with a more equitable growth pattern in South Korea, we wrote “India stands in some danger of going Brazil’s way, rather than South Korea’s”. Recent experience vindicates this apprehension. Interestingly, in the meantime, Brazil has substantially changed course, and adopted far more active social policies, including a constitutional guarantee of free and universal healthcare as well as bold programmes of social security and economic redistribution (such as Bolsa Familia). This is one reason why Brazil is now doing quite well, with, for instance, an infant mortality rate of only 9 per 1,000 (compared with 48 in India), 99 per cent literacy among women aged 15-24 years (74 per cent in India), and only 2.2 per cent of children below five being underweight (compared with a staggering 44 per cent in India). While India has much to learn from earlier experiences of growth-mediated development elsewhere in the world, it must avoid unaimed opulence—an undependable, wasteful way of improving the living standards of the poor.

India’s Decline in South Asia

One indication that something is not quite right with India’s development strategy is the fact that India has started falling behind every other South Asian country (with the partial exception of Pakistan) in terms of social indicators, even as it is doing so well in terms of per capita income (see table below).

Seeing its neighbours, India’s poor could well wonder what economic growth has got them.

The comparison between Bangladesh and India is a good place to start. During the last 20 years or so, India has grown much richer than Bangladesh: per capita income was estimated to be 60 per cent higher in India than in Bangladesh in 1990, and 98 per cent higher (about double) in 2010. But during the same period, Bangladesh has overtaken India in terms of a wide range of basic social indicators: life expectancy, child survival, fertility rates, immunisation rates, and even some (not all) schooling indicators such as estimated “mean years of schooling”. For instance, life expectancy was estimated to be four years longer in India than in Bangladesh in 1990, but it had become three years shorter by 2008. Similarly, the child mortality rate was estimated to be about 24 per cent higher in Bangladesh than in India in 1990, but it was 24 per cent lower in Bangladesh in 2009. Most social indicators now look better in Bangladesh than in India, despite Bangladesh having barely half of India’s per capita income.

No less intriguing is that Nepal also seems to be catching up rapidly with India, and even overtaking India in some respects. Around 1990, Nepal was way behind India in terms of almost every development indicator. Today, social indicators for both countries are much the same (sometimes a little better in India still, sometimes the reverse), in spite of per capita income in India being about three times as high as in Nepal.

To look at the same issue from another angle, Table 2 displays India’s “rank” among South Asia’s six major countries (excluding tiny Maldives), around 1990 as well as today (more precisely, in the latest year for which comparable international data are available). As expected, in terms of per capita income, India’s rank has improved—from fourth (after Bhutan, Pakistan and Sri Lanka) to third (after Bhutan and Sri Lanka). But in most other respects, India’s rank has worsened, in fact, quite sharply in many cases. Overall, India had the best social indicators in South Asia in 1990, next to Sri Lanka, but now looks second-worst, ahead of only Pakistan. Looking at their South Asian neighbours, the Indian poor are entitled to wonder what they have gained—at least so far—from the acceleration of economic growth.

India and China

One of the requirements of successful growth-mediated development is the skilful use of the opportunities provided by increasing public revenue. There are interesting and important contrasts in the policies followed by different countries in this respect. Since China is often cited by advocates of a single-minded focus on economic growth, it is interesting to compare what China does with what India has been doing. China makes much better use of the opportunities offered by high economic growth to expand public resources for development purposes. For example, government expenditure on healthcare in China is nearly four times that in India (after adjusting for “purchasing power parity”—the gap is even larger otherwise). China does, of course, have a larger population and a higher per capita income than India, but even as a ratio of GDP, public expenditure on health is much higher in China (about 2.3 per cent) than in India (around 1.4 per cent).

The RTI Act may not apply to information with private corporations but it can help contain the state-corporate nexus.

As Table 1 illustrates, China has much higher values of most social indicators of living standards, such as life expectancy (73 years in China and 64 years in India), infant mortality rate (16 per thousand in China and 48 in India), mean years of schooling (estimated to be 7.6 years in China, compared with only 4.4 years in India), or the coverage of immunisation (very close to universal in China but only around two-thirds in India, for DPT and measles). While India has nearly caught up with China in terms of the rate of economic growth, it seems quite far behind China in terms of the use of public resources for social support, and correspondingly, it has not done nearly as well in translating growth into rapid progress of social indicators. While there are also, undoubtedly, other factors behind the China-India contrast, the differing use of the fruits of growth for social support would seem to be an important influence in this contrasting picture.

It is not at all our purpose to argue that India should learn from China in every respect. India has reasons to value its democratic institutions. Even with all their limitations, these institutions allow for a wide variety of voices to be heard, and facilitate significant opportunities for various forms of public participation in governance. There are, of course, many failings of Indian democracy (which we have discussed in our writings), but there are big democratic achievements as well, and also the hindrances can be addressed through democratic battles to remove them. If China officially executes more people in a week than India has done since Independence (and this is true of a shockingly large number of weeks every year in China), this comparison, like many others involving legal and human rights of citizens, is not to India’s disadvantage. If there is something to learn from China, especially about how to ensure that the fruits of economic growth are more widely shared, then that is a case for learning from what there is to learn, not a case for blind imitation.

Not even one of the 315 editors and senior leaders of the print and electronic media in a survey were SC or ST.

The China-India contrast does, however, raise another interesting question: could it be that India’s democratic system is a barrier to using the fruits of economic growth for the purpose of enhancing health, education and other aspects of “social development”? In addressing this question, there is some possibility of a sense of nostalgia. When India had a very low rate of economic growth, a common argument coming from the critics of democracy was that democracy was hostile to fast economic growth. It was hard, at that time, to convince the anti-democratic advocates that fast economic growth depends on the friendliness of the economic climate, rather than on the fierceness of political systems. That debate on the alleged contradiction between democracy and economic growth has now ended (not least because of the high economic growth rates of democratic India), but a similar scepticism about democracy seems to be now emerging, suggesting an alleged inability of democratic systems to pursue public health, public education and other socially supportive arrangements.

It is important in this context to understand how democratic decisions emerge and how policies get adopted. What a democratic system achieves depends greatly on the issues that are politicised, which contributes to their advancement. Some issues are extremely easy to politicise, such as the calamity of a famine—and as a result famines tend to stop abruptly with the establishment of a democratic political system. But other issues—less spectacular and less immediate—present a much harder challenge. Using democratic means for remedying inadequate coverage of public healthcare, non-extreme undernourishment, or inadequate opportunities for school education demands more from democratic practice—more vigour and much more range.

India-China comparison tends to focus on the horse race of relative rates of overall growth.

Authoritarian systems can change their policies very quickly, when the leaders want that, and it is to the credit of the Chinese political leaders that they have focused so much on social interventions in education, healthcare and other supportive mechanisms to advance the quality of life of the Chinese people. But authoritarianism does not, of course, provide any kind of guarantee that the social commitments will emerge (they clearly have not in North Korea or Burma), or that they would invariably be stable and non-fragile (there have been sharp variations in the past even in China, including its having the largest famine in world history during the failure of the Great Leap Forward initiative). Even China’s commitment to broad-based public healthcare has had ups and downs, and came close to being undone: the coverage of the rural cooperative medical system crashed from 90 per cent to 10 per cent between 1976 and 1983 (when market-oriented reforms were initiated), and stayed around 10 per cent for a full 20 years. During this period of abdication of state responsibility for healthcare in China, the progress of health-related indicators (such as life expectancy and child survival) slowed down sharply. This led eventually to another U-turn, around 2004-5, when the rural cooperative medical system was rebuilt, with the coverage rising again to 90 per cent or so within three years (Shaoguang Wang, ‘Double Movement in China’, Economic and Political Weekly, Dec 27, 2008).

You call this education? A government school in Lucknow. (Photograph by Nirala Tripathi)

There is, in fact, no real barrier in India in combining multi-party democratic governance with active social intervention. But what would be needed is much greater public engagement with the central demands of justice and development through more vigorous democratic practice. The development of the welfare state in Europe has many lessons to offer here. As it happens, public debate is quite powerful in India, but the range of engagement has often been quite limited. The India-China comparisons tend to concentrate mostly on the horse race of relative rates of overall economic growth rather than the variations in mediation for development. Underlying this dialogic narrowness, there is a social picture. A big part of the Indian population—a fairly small minority but still quite large in absolute numbers—has been doing very well indeed, through the process of high growth alone; they do not depend on social mediation. In contrast, more vigorous mediation would be very important for other Indians—many more, in fact—whose lives are affected by ill health, undernourishment, lack of healthcare and other deprivations.

Power Imbalances, Old and New

The neglect of elementary education, healthcare, social security and related matters in Indian planning fits into a general pattern of pervasive imbalance of political and economic power that leads to a massive neglect of the interests of the unprivileged. Other glaring manifestations of this pattern include disregard for agriculture and rural development, environmental plunder for private gain with huge social losses, large-scale displacement of rural communities without adequate compensation, and the odd tolerance of human rights violations when the victims come from the underdogs of society.

But China makes much better use of growth to extend public resources for development.

None of this is entirely new, and much of it reflects good old inequalities of class, caste and gender that have been around for a long time. For instance, the fact that not even one of the 315 editors and other leading members of the printed and electronic media in Delhi surveyed recently by the Centre for the Study of Developing Societies belonged to a scheduled caste or scheduled tribe, and that at the other end, 90 per cent belonged to a small coterie of upper castes that make up only 16 per cent of the population, obviously does not help to ensure that the concerns of Dalits and adivasis are adequately represented in public debates. Nor is India’s male-dominated Lok Sabha (where the proportion of women has never crossed 10 per cent so far) well placed to address the concerns of women—not only gender issues, but also other social issues in which women may have a strong stake. A similar point applies to rural-urban disparities: a recent study found that rural issues get only two per cent of the total news coverage in national dailies.
Some of these inequalities are diminishing, making it easier for disadvantaged groups to gain a voice in the system (even the proportion of women in the Lok Sabha, abysmally low as it is, is about three times as high today as it was 50 years ago). However, new or rising inequalities are also reinforcing the vicious circle of disempowerment and deprivation. For instance, the last 20 years have seen a massive growth of corporate power in India, a force that is largely driven—with some honourable exceptions—by unrestrained search for profits. The growing influence of corporate interests on public policy and democratic institutions does not particularly facilitate the reorientation of policy priorities towards the needs of the unprivileged.

The growing influence of corporate interests on public policy is not reorienting policy priorities towards the unprivileged.

It is important to recognise the influence of elements of the corporate sector on the balance of public policies, but it would be wrong to take that to be something like an irresistible natural force. India’s democratic system offers ways and means of resisting the new biases that may emanate from the pressure of business firms. One instructive example both of a naked attempt to denude an established public service and of the possibility of defeating such an attempt is the long saga of attempted takeover of India’s school meal programme by biscuit-making firms. The “midday meal” programme, which provides hot cooked meals prepared by local women to some 120 million children, with a substantial impact on both nutrition and school attendance, had been eyed for many years by food manufacturers, especially the biscuits industry.

A few years ago, a “Biscuit Manufacturers’ Association” (BMA) launched a massive campaign for the replacement of cooked school meals with branded biscuit packets. The BMA wrote to all members of Parliament, asking them to plead the case for biscuits with the minister concerned and assisting them in this task with a neat pseudo-scientific precis of the wonders of manufactured biscuits. Dozens of MPs, across most of the political parties, promptly obliged by writing to the minister and rehashing the BMA’s bogus claims. According to one senior official, the ministry was “flooded” with such letters, 29 of which were obtained later under the Right to Information Act. Fortunately, the proposal was firmly shot down by the ministry after being referred to state governments and nutrition experts, and public vigilance exposed what was going on. The minister, in fact, wrote to a chief minister who sympathised with the biscuit lobby: “We are, indeed, dismayed at the growing requests for introduction of pre-cooked foods, emanating largely from suppliers/marketers of packaged foods, and aimed essentially at penetrating and deepening the market for such foods” (Hindustan Times, Apr 14, 2008).

The bigger battle is still on. The BMA itself did not give up after being rebuked by the Union minister for human resource development. It proceeded to write to the Union minister for women and child development, with a similar proposal for supplying biscuits to children below the age of six years under the Integrated Child Development Services (ICDS). Other food manufacturers are also on the job, and despite much vigilance and resistance from activist quarters (and the Supreme Court), they seem to have made significant inroads into child feeding programmes in several states.

Similar concerns apply in other fields of social policy. For instance, the prospects of building a public healthcare system in India are unlikely to be helped by the growing influence of commercial insurance companies, very active in the field of health. India’s health system is already one of the most privatised in the world, with predictable consequences—high expenditure, low achievements and massive inequalities. Yet, there is much pressure to embrace this “American model” of healthcare provision, despite the international recognition in the health community of its comparatively low achievement and significantly high cost.

Rosy picture Himachal leads the way in social indices. (Photograph by Tribhuvan Tiwari)

However, recent events have also shown the possibility of fighting back, not just in terms of winning isolated battles against inappropriate corporate influence, as happened with the biscuits lobby, but also in terms of building institutional safeguards against abuses of corporate power. The Right to Information Act, for instance, though not directly applicable to information held by private corporations, is a powerful means of watching and containing the state-corporate nexus, as the biscuits story illustrates. Regulations and legislations pertaining to corporate funding of political parties, corporate social responsibility, financial transparency, environmental standards, and workers’ rights also have an important role to play in disciplining the corporate sector.

The Case for a Comprehensive Approach

The need for growth-mediated development has not been completely ignored in Indian policy debates. The official goal of “inclusive growth” could even claim to have much the same connotation. However, the rhetoric of inclusive growth has gone hand in hand with elitist policies that often end up promoting a two-track society whereby superior (“world-class”) facilities are being created for the privileged, while the unprivileged receive second-rate treatment, or are left to their own devices, or even become the target of active repression—as happens, for instance, in cases of forcible displacement without compensation, with a little help from the police. Social policies, for their part, remain quite restrictive (despite some significant, hard-won initiatives such as the National Rural Employment Guarantee Act), and are increasingly steered towards quick fixes such as conditional cash transfers. Their coverage, in many cases, is also sought to be confined to “below poverty line” (BPL) families, a narrowly defined category that tends to shrink over time as per capita incomes increase, which may even look like a convenient way of ensuring that social welfare programmes are “self-liquidating”.

In Delhi, Rs 30 a person a day can get a kg of rice and a one-way bus ticket three stops down.

Cash transfers are increasingly seen as a potential cornerstone of social policy in India, often based on a distorted reading of the Latin American experience in this respect. There are, of course, strong arguments for cash transfers (conditional or unconditional) in some circumstances, just as there are good arguments for transfers in kind (such as midday meals for school children). What is remarkably dangerous, however, is the illusion that cash transfers (more precisely, “conditional cash transfers”) can replace public services by inducing recipients to buy health and education services from private providers. This is not only hard to substantiate on the basis of realistic empirical reading; it is, in fact, entirely contrary to the historical experience of Europe, America, Japan and East Asia in their respective transformation of living standards. Also, it is not how conditional cash transfers work in Brazil or Mexico or other successful cases today.

In Latin America, conditional cash transfers usually act as a complement, not a substitute, for public provision of health, education and other basic services. The incentives work for their supplementing purpose because the basic public services are there in the first place. In Brazil, for instance, basic health services such as immunisation, antenatal care and skilled attendance at birth are virtually universal. The state has done its homework—almost half of all health expenditure in Brazil is public expenditure, compared with barely one quarter (of a much lower total of health expenditure) in India. In this situation, providing incentives to complete the universalisation of healthcare may be quite sensible. In India, however, these basic services are still largely missing, and conditional cash transfers cannot fill the gap.

Poor initiatives Jairam and Montek discussing the poverty line at a press conference. (Photograph by Jitender Gupta)

The pitfalls of “BPL targeting” have become increasingly clear in recent years. First, there is no reliable way of identifying poor households, and the exclusion errors are enormous: at least three national surveys indicate that, around 2004-05, about half of all poor households in rural India did not have a “BPL card”. Second, India’s poverty line is abysmally low, so that even if all the BPL cards were correctly and infallibly allocated to poor households, large numbers of people who are in dire need of social support would remain excluded from the system. In 2009-10, for instance, the official poverty line in Delhi was around Rs 30 per person per day. This is just about enough to buy one kilogram of rice and a one-way bus ticket that would take you three stops down the road. Third, BPL targeting is extremely divisive, and undermines the unity and strength of public demand for functional social services, making a collaborative right into a divisive privilege.

The power of comprehensiveness in social policy is evident not only from international and historical experience, but also from contemporary experience in India itself. In at least three Indian states, universal provision of essential services has become an accepted norm. Kerala has a long history of comprehensive social policies, particularly in the field of elementary education—the principle of universal education at public expense was an explicit objective of state policy in Travancore as early as 1817. Early universalisation of elementary education is the cornerstone of Kerala’s wide-ranging social achievements.

Less well known, but no less significant, is the gradual emergence and consolidation of universalistic social policies in Tamil Nadu (see ‘Understanding Public Services in Tamil Nadu’ by Vivek S., PhD thesis, 2010, Syracuse University, and the literature cited there). Tamil Nadu was the first state to introduce free and universal midday meals in primary schools. This initiative, much derided at that time as a “populist” programme, later became a model for India’s national midday meal programme, widely regarded today as one of the best “centrally sponsored schemes”. The state’s pioneering efforts in the field of early child care, under the ICDS, has made great strides towards the provision of functional anganwadis (child care centres), accessible to all, in every habitation. Tamil Nadu, unlike most other states, also has an extensive network of lively and effective healthcare centres, where people from all social backgrounds can get reasonably good healthcare, free of cost. NREGA, another example of universalistic social programme, is also doing well in Tamil Nadu: employment levels are high (with about 80 per cent of the work going to women), wages are usually paid on time and leakages are relatively small. Last but not the least, Tamil Nadu has a universal public distribution system (PDS), in both rural and urban areas. Tamil Nadu’s pds supplies not only foodgrains but also oil, pulses and other food commodities, with astonishing regularity and minimal leakages.

Protests against Vedanta in Orissa

Himachal Pradesh began this journey much later than Kerala and Tamil Nadu, but is catching up very quickly. This is most evident in the field of elementary education: starting from literacy levels similar to the dismal figures for Bihar or Uttar Pradesh around the time of India’s Independence, Himachal Pradesh caught up with the highest-performing Kerala within a few decades. This “schooling revolution” was based almost entirely on a policy of universal provision of government schools, and even today, elementary education in Himachal Pradesh is overwhelmingly in the public sector. Like Tamil Nadu, Himachal Pradesh has a well-functioning pds, providing not only foodgrain but also pulses and oil and covering both “BPL” (Below Poverty Line) and “APL” (Above Poverty Line) families. Himachal Pradesh has also followed comprehensive principles not only in the provision of essential social services (including schooling facilities, healthcare and child care) but also in the provision of basic amenities such as roads, electricity, drinking water and public transport. For instance, in spite of adverse topography and scattered settlements, 98 per cent of Himachali households had electricity in 2005-6.

It is perhaps not an accident that Kerala, Tamil Nadu and Himachal Pradesh also tend to have the best social indicators among all major Indian states. For instance, a simple index of children’s health, education and nutrition achievements clearly places these three states at the top (Dreze, R. Khera, S. Narayanan, 2007, ‘Early Childhood in India: Facing the Facts’, Indian Journal of Human Development, 1(2), Jul-Dec 2007). Despite wide historical, cultural and political differences, they have converged towards a similar approach to social policy, and the results are much the same too. There is a crucial lesson here for other Indian states, and indeed for the country as a whole.

A Concluding Remark

We hope that the puzzle with which we began is a little clearer now. India’s recent development experience includes both spectacular success as well as massive failure. The growth record is very impressive, and provides an important basis for all-round development, not least by generating more public revenue (about four times as much today, in real terms, as in 1990). But there has also been a failure to ensure that rapid growth translates into better living conditions for the Indian people. It is not that they have not improved at all, but the pace of improvement has been very slow—even slower than in Bangladesh or Nepal. There is probably no other example in the history of world development of an economy growing so fast for so long with such limited results in terms of broad-based social progress.

There is no mystery in this contrast, or in the limited reach of India’s development efforts. Both reflect the nature of policy priorities in this period. But as we have argued, these priorities can change through democratic engagement—as has already happened to some extent in specific states. However, this requires a radical broadening of public discussion in India to development-related matters—rather than keeping it confined to simple comparisons of the growth of the gnp, and naive admiration (implicit or explicit) of the high living standards of a relatively small part of the population. An exaggerated concentration on the lives of the minority of the better-off, fed strongly by media interest, gives an unreal picture of the rosiness of what is happening to Indians in general, and stifles public dialogue of other issues. Imaginative democratic practice, we have argued, is essential for broadening and enhancing India’s development achievements.

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Jean Dreze is Visiting Professor, Department of Economics, Allahabad University. Nobel laureate Amartya Sen is Lamont University professor and Professor of Economics and Philosophy at Harvard University.